Changes in the regulatory landscape have given great prominence to the reasonableness of compensation. Reasonable compensation is a requirement of virtually every aspect of financial services, and the attention is likely to increase with every new regulation. Compensation has also been the prime target for recent litigation.
After years of certifying the reasonableness of compensation, Dalbar found little difficulty with investment and insurance products or services such as record keeping, administration or custody. The products and services have a well-defined role, and while there have been excesses, these excesses are easily identified and corrected.
Advisor compensation, however, has been a challenge. While the amount of compensation is easily determined, the role and services provided are often poorly defined. These inadequate explanations, both verbal and written, create the illusion of excess. For the most part, it is the advisors themselves that make their compensation appear excessive. Advisors who articulate a well-defined and valuable role and can explain the services they provide to the average consumer generally have no trouble proving that their compensation is reasonable.
There are several ways that advisors devalue their role so that compensation appears to be excessive. The two most common ways that advisors undervalue their role are in the definition of that role and describing the associated services. Amazingly, these failures can be corrected at virtually no cost, but will require a change in thinking and in language.
Defining the Role
Unlike any other professional, advisors often think of their role as selling products and services. Imagine doctors thinking of themselves as salesmen of hospital stays and operations. Or attorneys as lawsuit salesmen. Or auto mechanics as salesmen of car parts. Or athletes as salesmen of admission tickets to games! Such roles would not come close to explaining their compensation, even though those roles give rise to their compensation.
Like the doctor, attorney, mechanic and athlete, the advisor has a greater mission that should define his or her role. Among the best that we have seen has been “…to develop recommendations and monitor progress to a personal goal.” This is a role that has an enormous value to clients.
The second area of personal devaluation for advisors are the services provided. The most frequently used description of advisor services is an unnecessarily forced fit into a regulatory requirement. Advisors description of services often recite “…provide education regarding…” Others describe even less value with statements like “…provide information…” On a less formal basis, advisors often describe their service as “hand holding.” These are a few of many self-deprecating terms advisors use to define their services.
A more accurate description of what advisors actually do translates to reasonable compensation. The following are a number of such services that are routinely provided by many advisors today.
- Identify individuals/businesses that could benefit from or are in need of the services of a financial professional.
- Explore and discover what the interests, goals, needs, situation and preferences are for clients and potential clients and make appropriate recommendations.
- Monitor market conditions and other factors that may affect clients and determine if and when action should be recommended.
- Answer questions and concerns from clients as they arise.
- Periodically review the situation of each client to determine if changes are prudent and make appropriate recommendations.
- Manage investments in client portfolio to pursue a risk/reward objective.
- Review investment results with clients.
- Provide administrative support for clients, if and when needed.
By simply describing services in an appropriate way, it becomes unnecessary to perform additional tasks to justify compensation or to reduce compensation to reflect a poorly described set of services.
Finding of Reasonableness
The well-articulated role and properly described services explain the benefits to clients, but the ultimate step in determining reasonableness is the cost. Compensation is inherently reasonable when the benefits are worthwhile and the cost to the client has a direct relationship to the advisor’s cost.
The final step in determining reasonableness is to compare the advisor’s compensation to the advisor’s cost. This comparison provides for a profit margin, which is typically as much as 50% but can exceed that level under certain circumstances. Depending on the purpose for assessing reasonableness, this comparison may be done in aggregate for all clients, for specific sets of clients or for individual clients.
The historical experience is that the overwhelming majority of situations are found to be reasonable, but there are usually a few that need attention.
In addition to proving reasonableness, a well-articulated role and a clear description of advisor services also provides a powerful marketing message when faced with discriminating prospective clients and powerful competitors. Existing clients are also reassured of the wisdom of their choice on hearing such a presentation.